Nic Cicutti: Is the FCA looking to nudge you off trail?

Whenever guests come to our house, we like to make them welcome. Aside from offers of tea or coffee, glasses of wine, food and the like, our downstairs loo carries a wide range of reading material to divert them during their stay.

Visitors can choose between magazines such as Good Housekeeping, Horse & Hound, Country Life and Scootering, as well a couple of dozen books on topics ranging from poetry to comedy to psychology and self-improvement.

The self-improvement section includes Malcolm Gladwell’s “The Tipping Point” and Richard Thaler’s “Nudge: Improving Decisions about Health, Wealth, and Happiness”, both of which advance similar ideas about human behaviour.

Essentially, the two authors imply that human beings do not make rational choices about their lives, they are “nudged” or “persuaded” into reaching those decisions by circumstances they do not necessarily understand or fully control.

In Gladwell’s case, the tipping point is the behaviour of others in a social network with the capacity to inspire and influence behaviour. For Thaler, the question is about framing an argument in such a way as to nudge them in to making the “right” decision (again, my emphasis).

Thaler describes this as creating a “choice architecture”, arranging things in a way that retains freedom of choice while still promoting what they believe is the appropriate path for people to take.

If you’ve stayed with me so far, you might be wondering what all the above has to do with financial services in general and financial advisers’ business practices in particular.

Well, I was reminded of Thaler’s nudge theory by the recent publication of the FCA’s board minutes for June, in which the regulator discussed issues facing the industry, including that of remuneration.

We already know that the FCA is unhappy with the potential for dealing bias in the trend among IFAs to levy charges only if a sale is made. This was also made clear by FCA chief executive Martin Wheatley in a speech last month.

What is also becoming evident is the growing sense of unease over trail commission, more specifically what Money Marketing described in an editorial last week as “the risk of ‘poor consumer outcomes’ from allowing trail commission to continue on pre-RDR business.”

Essentially, what appears to concern the FCA is the possibility that given its original acceptance of pre-RDR trail continuing to be paid indefinitely,some advisers may be taking advantage of the fact by leaving their clients’ portfolios untouched and un-reviewed.

By doing so, they are avoiding the difficult arguments necessary to ensure continued trail payments post-RDR – or so the FCA believes may be happening.

There are several ways of looking at this question. One is to assume the FCA will simply carry out one of its thematic reviews and conclude that the current position with regard to trail commission is leading to these “poor consumer outcomes”. At which point, a retrospective sunset clause is indeed applied to pre-RDR trail.

As Money Marketing argues, this could be potentially disastrous: many advisers have built business models predicated on foregoing initial income in return for a recurring revenue stream from trail. That being the case, it is possible any move to insert a sunset clause into pre-RDR trail arrangements might lead to legal action.

But is this what the FCA is looking to do? My own guess is that the publication if its board minutes is designed to achieve something subtly different, namely to start “nudging” financial advisers into altering their behaviour with respect to trail commission.

Essentially, the aim is to promote the idea that trail is something that is negotiated, agreed and then earned by an adviser, in return for providing a tangible service than can be measured and reviewed – in just the same way as the performance of a portfolio is itself assessed on a regular basis.

Were advisers to move to that model of service and ongoing remuneration with their clients, it is unlikely that the regulator will have any argument with their charging structures. It is only in the event such a scenario does not happen that we can expect the FCA to move to the next stage of the process.

It is hard to argue with this point of view. Apart from anything else, it is clear from the FSA’s own statements over several years prior to the RDR coming into effect that it believed trail commission as something that should be earned through ongoing servicing of a client’s products and not simply paid as the by-product of a sale years before.

Nor is the idea of a sunset clause with respect to trail anything new: Skandia was arguing for one two years ago, suggesting that it take place five years after the RDR came into effect.

In that respect, rather than financial advisers reacting defensively to the FCA board minutes, they should be using it as the “nudge” they need to move to the next stage of their post-RDR business planning.

Without advisers changing how they operate, the alternative is for the FCA to create a pre- and post-RDR level playing field over trail. You might want to call it “nudge-with-a-threat” – and I don’t think there’s much time before one turns into the other.

It is true that many of us built our business on trail commissions (i, for one, over 25 years). In return for those trail commissions which were paid for by a reduced initial commission, I have provided all my clients with a specific ongoing service.
So, legally, what right has anyone to switch it off?
The nomadic advisers sucked every penny out of the commision options at the front end so it seems that they win? Is that fair?
The life companies in particular cannot cope with an adviser-fee option so this may force advisers to surrender investments early and reinvest them to retain their ongoing income – in which case it may be that the consumer would lose out by suffering early surrender penalties or MVA’s on With Profit Funds.
Should the trail commission be switched off, will the consumer receive commensurate extra investment returns and thus be able to pay me for ongoing services? I doubt it in which case it is another windfall profit that the FCA has given to the product providers.
Time the FCA remembered that it is there primarily to prtotect the consumer, not follow it’s own blinkered opinions.